Peek-a-boo! You may be surprised to know that the time to start planning for your baby’s college education is now.
Although it may be hard to imagine your little one sporting a high school cap and gown, the school years pass by much more quickly than many parents anticipate and they suddenly find themselves wishing they had started sooner saving for college. Fortunately, there are many resources and strategies available to be ahead of the game.
College cost calculators are a good place to start for understanding what you can expect. For example, the Blackrock College Cost Calculator indicates that the sticker price for your baby to earn an undergraduate degree at Indiana University-Bloomington – including tuition, housing, books and other expenses – will potentially cost more than $$265,000.* Four years at a private college will be more expensive. Beyond that, your child may attend professional or graduate school.
As overwhelming as that total price tag may sound, the net price for college might end up being much lower if your child wins scholarships, receives grants, gets financial aid, builds savings with a job, earns course credits in high school or at a community college, or lives at home while attending school. Nevertheless, if you want to help pay for their higher education, you can build a substantial nest egg for that purpose over the next eighteen years.
While your goal may be to eliminate the need for college debt or loans entirely, making this your financial priority is often not the best strategy. Chad Stevens, CFP® a Certified Financial Planner with Key Private Bank in Central Indiana, says that first you need to develop a personal comprehensive financial plan with a qualified specialist that takes into account short-term, mid-term and long-term goals. “I advise parents to prioritize retirement savings over college savings and to purchase life and disability insurance to fund educational expenses in case of a working parent’s premature death or disability,” says Stevens.
According to Sallie Mae’s How America Saves for College 2016, the most common way for parents to save for college is with a general savings account – but this is actually not the best method.
Stevens tells parents it is more advantageous to establish a 529 account for each child because assets can grow tax-free and withdrawals for qualified expenses are also tax-free. And if you have sufficient income, you can contribute up to $14,000 in a single year, or even a larger lump sum within certain guidelines, to a 529 without incurring a gift tax.
Opening a 529 plan can be done in any state, but if you are a Hoosier, Indiana’s CollegeChoice 529 program offers a distinct advantage. Residents are eligible for a state income tax credit of 20% of your annual contribution to your child’s 529 account up to a $1,000 credit per year. Grandparents, other family members and friends who are Indiana taxpayers also enjoy this tax benefit when they contribute to your CollegeChoice 529.
Flexibility is another benefit of a 529. For one thing, money can be transferred to another beneficiary if your child doesn’t use all of the accumulated assets. Moreover, CollegeChoice funds may be used for expenses at either an in-state and out-of-state college that meets certain criteria. Best of all, 529 assets owned in your name have a minimal impact on how colleges calculate your child’s financial aid eligibility.
Like all 529 programs, Indiana’s CollegeChoice offers several investment options, from a managed age-based portfolio to a savings account, and you can change your investment strategy at any time to fit your individual preferences. “I suggest an initial growth investment strategy, which you can change to a more conservative strategy to protect assets as your baby nears college age,” says Stevens, adding that “as you shift toward bonds, though, watch interest rates, which will devalue bonds.” Over time, the power of compound growth can have a significant impact on achieving your goal.
The Coverdell Education Savings Account, another type of tax-advantaged savings account, is different from a 529 in that it allows you to use the funds for K-12 private school tuition. However, as a savings vehicle for higher education, the Coverdell loses out to the 529 because of its lower annual contribution limit and other restrictions. Old-fashioned UGMA (Uniform Gift to Minor’s Act) and UTMA (Uniform Transfer to Minor’s Act) custodial accounts also have several disadvantages, most particularly that you lose control of how its assets are spent when your child reaches Indiana’s age of majority (18- 21).
Stevens advises against using your own Roth IRA for educational expenses. Instead, he recommends introducing your child over time to increasingly sophisticated concepts of money and the cost of living, and encouraging him or her to appreciate the value of a dollar by having a summer job of their own. But that’s a whole other subject that can wait for now! Enjoy your baby and this special time – but start planning now to help give your little bundle of joy the brightest future possible.
*Assumes historical 5% annual education inflation rate